Small Cap Owning Large Cap, Mass Hysteria!

The title of this post is a play on the bit in the movie Stripes when Bill Murray talks about dogs and cats living together.

You probably heard about the niche ETF (naming names is difficult for compliance reasons) that essentially grew too large in assets to track its niche. It isn’t just a niche fund it is the small cap version of that niche. It became the tail wagging the dog. Creations had to be suspended and the market price swung wildly from the fund’s NAV. There was similar havoc wrought on the 3x version of the fund as well.

The fund sponsor will be able to change the index later in the year to move up in cap size so the fund will skew larger but still be smaller than the large cap version of the fund. In the meantime, the small cap fund will have exposure to the large cap version to hopefully allow it to function as an ETF until the index can be altered.

Is that a big deal, the small cap niche fund owning shares of the large cap niche fund? In this case, probably not. According to ETFreplay.com the correlation between the two was at 0.92 as of the close yesterday. Over the last two years the correlation has usually been even tighter than 0.92 so someone feeling they must have small cap exposure to this niche can probably still accomplish that now, and then after the index is changed to go a little larger.

I don’t take this as a story about ETFs failing, I take it more to be that owning ETFs requiring work. There is no such thing as set and forget, there can be set and monitor with a willingness to take action when needed. Whether this is an instance where action is required is up to the end user but anyone owning this fund should at least be current with the story.